Deficits must be paid for one way or another. Some third world countries have the bad habit of simply printing more money, creating inflation. However, debtor nations have wisened up to that tactic and loan in dollars or a more stable currency and require payment back into that currency. The U.S. dollar has for many years been a primary international currency that funds nation-states.
In the United States, the way deficits are handled is to finance them through U.S. treasury bonds and other government issued investment vehicles. This method of finance in fact dismantles the logical fallacy that is the laffer curve. The laffer curve is at the center of the basic philosophy of what Reagan was hoping to accomplish. By lowering taxes, especially taxes in higher income brackets where there is a high degree of investment vrs consumption, the assumption was that there would be an influx of capital into the marketplace, fueling growth that would bring down unemployment and increase tax revenues. However, when you look at the basic calculation behind this logic, it doesn’t make sense.
Let’s say on average, the income tax reduction went to 40% investment and 60% consumption. So for every $10 dollars of income tax relief, $4 went into the capital markets. However, for every dollar of deficit you run up, 100% of that money comes from the capital markets, resulting in a net decrease of $6 from the capital markets. The results of this was a predicament during the Reagan administration, that real interest rates (interest rates less the inflation rate) actually increased. When real interest rates are high, it has a negative affect on the net present value of all future returns on investments ROI. It also requires business to shy away from long-term investments in favor of short term.
The results in the 1980 capital markets was a foregone conclusion. Welcome to the era of junkbonds, and leveraged buyouts. A focus on existing assets rather than investment in future assets hurt the economy of the Reagan years and that lack of investment in plant and material in many industries resulted in a serious decline in the manufacturing sector in the United States and a significant realignment and displacement of the U.S. economy. Luckily for the U.S., we were bailed out by a technological revolution and the creation of many new products. However, the manufacture of U.S. created products began in the Reagan years, and continues today, to be overseas. The day of the good paying manufacturing job was virtually at an end, compliments of “Voodoo Economics.”
In the next essay, I will address some other by-products of Reagbushonomics and how it impacted income distribution in the U.S. and address the unintended Keynesian aspects of Reagbushonomics.